In Switzerland there has been a sharp increase in the number of initial coin offerings (ICOs) and a corresponding increase in the number of inquiries about the applicability of regulation. ICOs are a digital blockchain based form of public fundraising for entrepreneurial purposes. FINMA is publishing guidelines, which complement its earlier FINMA Guidance 04/2017, setting out how it intends to treat ICOs.

Each case to be decided on its individual merits

Regulations are not applicable to all ICOs so depending on the manner in which ICOs are designed, each ICO must be decided a case-by-case basis. As set out in FINMA Guidance 04/2017, there are several areas in which ICOs are potentially impacted by financial market regulation. At present, there is no ICO specific regulation, nor is there relevant case law or consistent legal doctrine.

FINMA’s principles focus on the function and transferability of tokens

FINMA in assessing ICOs will focus on the economic function and purpose of the tokens ( i.e. the blockchain based units ) issued by the ICO organizer. The key factors are the underlying purpose of the tokens and whether they are already tradeable or transferable. At present, there is no generally recognized terminology for the classification of tokens either in Switzerland or internationally. FINMA categorizes tokens into three types, but hybrid forms are possible:

Payment tokens are synonymous with cryptocurrencies and have no further functions or links to other development projects. Tokens may in some cases only develop the necessary functionality and become accepted as a means of payment over a period of time.

Utility tokens are tokens which are intended to provide digital access to an application or service.

Asset tokens represent assets such as participations in real physical underlyings, companies, or earnings streams, or an entitlement to dividends or interest payments. In terms of their economic function, the tokens are analogous to equities, bonds or derivatives.

A Focus on anti-money laundering and securities regulation

FINMA’s analysis indicates that money laundering and securities regulation are the most relevant to ICOs. The Anti-Money Laundering Act contains requirements for financial intermediaries to establish the identity of beneficial owners as such KYC ( Know Your Customer ) is a must. The law aims to protect the financial system against the risks of money laundering and the financing of terrorism. Money laundering risks are especially high in a decentralised blockchain based system, in which assets can be transferred anonymously and without any regulated intermediaries.

Securities regulation is intended to ensure that market participants can base their decisions about investments on a reliable minimum set of information. Moreover, trading should be fair, reliable and offer efficient price formation.

On the basis of the above mentioned criteria (function and transferability), FINMA will handle ICOs as follows:

Payment ICOs: For ICOs where the token is intended to function as a means of payment and can already be transferred, FINMA will require compliance with anti-money laundering regulations. FINMA will not, however, treat such tokens as securities.

Utility ICOs: These tokens do not qualify as securities only if their sole purpose is to confer digital access rights to an application or service and if the utility token can already be used in this way at the point of issue. If a utility token functions solely or partially as an investment in economic terms, FINMA will treat such tokens as securities (i.e. in the same way as asset tokens).

Asset ICOs: FINMA regards asset tokens as securities, which means that there are securities law requirements for trading in such tokens, as well as civil law requirements under the Swiss Code of Obligations (e.g. prospectus requirements).

ICOs can also exist in hybrid forms of the above categories. Eg. Anti-money laundering regulation would apply to utility tokens that can also be widely used as a means of payment or are intended to be used as such.

FINMA wants to reduce the risks that ICOs can pose for investors and the above is the first step towards making ICO’s more regulated and understood by investors.